Valuing Private Equity
Venture Capital and Private Equity are often used interchangeably by the lay-person. However, there are significant differences between the two.
Venture capital focuses usually on young and unproven companies e.g. start-ups, and a non-controlling investment is made. However, private equity companies almost all the time invests a controlling stake in companies which have a longer operating history and are established with a base of customers, a portfolio of products and perhaps a history of profit.
When we value private equity, we need to differentiate between pre-cash and post-cash valuations. There are two reasons for this:
a) The pre-cash valuation may be lower because without the infusion of cash, the target cannot expand its block-buster product portfolio, or penetrate into new markets. Or the target will not have access to the superior network of the private equity firm.
b) The injection of private equity cash may leave the target with excess cash which they can invest in marketable securities, which when added to the value of operating assets will increase value.
From our experience, when we have a private equity investor willing to invest. Should we look at pre-cash or post-cash valuations ? The answer is," It depends."
If the investor has bargaining power e.g. being the only investor, then his share may be based on pre-cash valuation. If there is competition, it is likely that post-cash valuation will be used.
However, the method of valuation will still be based on the usual valuation techniques.
The only difference is will the private equity investor get a bigger or a smaller share of the company. And this can mean a world of difference.